IT Financials Glossary

Depreciation

Posted in Accounting by mgentle on August 26, 2010

Depreciation: the reduction in value of an asset over its useful life (usually several years) through usage or obsolescence.

There are several methods of depreciation, the simplest of which is the linear or straight-line method, which divides the cost equally across the lifetime of the asset. So a $90k server with a useful life of 3 years will have an annual depreciation of $30k.

The financial impact on IT costs of mixing up capex and opex should hopefully be clear. If the server is correctly capitalized, the IT department will incur no costs this year against the IT budget; instead it will be charged $30k per year for 3 years starting next year. If, however, the PO incorrectly assigns the purchase to an opex account, then the $90k would figure as a current-year cost and hit the IT budget.

Or, to use a less obvious example, if a development team inadvertently enters $90k worth of time entry against functional design (opex) instead of technical design (capex), then instead of being depreciated as part of a software asset from next year on, the $90k would figure as a current-year cost.

Very important: depreciation is not a cost in terms of money out of the bank! The cost is what the company paid to acquire the asset (in cash or through borrowing). Depreciation is an accounting exercise that allocates a portion of the asset’s cost to the current financial year. The term expense in “depreciation expense” does not refer to a cost, but to operating expense, or opex. (Confused? Don’t worry, so was I not too long ago!).

FURTHER READING: for an accounting view of fixed assets and depreciation check out the following article by Michael Sack Elmaleh.

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One Response

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  1. Amortization said, on April 5, 2011 at 20:06

    […] the technical term for the depreciation of non-material or intangible assets like patents, trademarks or brands. Filed Under: Accounting […]


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